Tough Times for Lenders : Financial Services Lawyer & Attorney : Winstead Law Firm : Finance, Banking, Bankruptcy

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(When we attend industry conferences, we bring you along by blogging on topics of interest to us, with our comments as a bonus. This is the second in a series of posting relating to, and from, the 2010 CMSA January Conference. [Link to Day 1] Our blogs on other conferences are found [i] under the "Market Trends" category in the archives on the right side of the page, or [ii] by a word or phrase search on the right side of the page [suggested search terms: looking glass; scorecard; pond].)

Technology Tip: darn, this American Airlines flight does NOT have GoGo Inflight Wi-Fi. I hate this. So, I'm forced to type this in Word, and then post it tomorrow morning from home. 

However, here's a tip on "how" I organize all of my passwords and PINs, including my password for GoGo:

- create a separate Contact card in Outlook for each website, frequent flyer\use membership, etc.; include the applicable website on the card

- be sure to password "protect" your phone\PDA (tip: use a password combination that you can enter with one hand, so that you can leave your other hand free)

Now, on to Day 2 . . .

Day 2 is the last day of the conference. It has a different feel than day one, in part because the crowd is significantly larger.

I've been told that when the CMSA planned this 2010 event, they anticipated @ 500 people would register for the conference. Whether is was the pain of an uneventful 2009 (read: no CRE money for no one), or simply wanting to be told that 2010 would be better (read: CRE money for someone . . . please), today it felt like every one of the registered 1,000 attendees crowded into the basement ballroom floor of the JW Marriott Hotel.

Yes, we're literally all "in this cramped CRE space together."

Today the program focused on different points of the CRE space, with appearances and comments by two members of the US House and by the Chairman of the FDIC. This posting will summarize the substantive items.

The comments by the elected and appointed officials will be included in a post later this week (or this weekend - I have to get caught up at "real" work).

Here are the highlights (with some commentary, of course) from the last session on Day 1 and several Sessions from Day 2.

LESSONS FROM CMBS 1.0: "THE WONDER YEARS"

Frankly, calling the "old" CMBS market\model "1.0" and then labeling the soon-to-come, "rejuvenated" CMBS market\model "2.0" strikes me as being very, very hopeful. From my perspective, CMBS 2.0 better be strikingly different and improved over CMBS 1.0. (Indeed, why are we so married to the CMBS model? As an Air Force brat, it strikes me as if we're focusing on making the bi-plane better.) And CMBS 2.0 better arrive quickly and with billions of Dollars. (Warning: 2.0 is no "CMBSuperman.")

Time will tell, of course.

But if the comments at this conference are correct:

• CMBS 2.0 will not arrive quickly
• 2.0 will not be the "proceeds party" that characterized CMBS 1.0, and
• 2.0 will not come close to bringing the liquidity needed to refi the huge amount of near-term loan maturities.

One panelist gave a very good description of the collateral damage to the CRE finance market caused by pushing CMBS 1.0 to the limits:

• Wall Street's intervention (or commodization) of CRE finance brought an incredible amount of liquidity to CRE
• Utilizing the CDO structure in the CRE space was a logical, yet terribly short-sighted mistake in that it effectively separated (or "de-linked" the unique credit risk inherent in CRE from the investment decision
• The liquidity party quickly spread across the CRE finance spectrum
• Wall Street underwriting, downward rate pressure, increase in proceeds and complicated credit "stack" structures quickly captured a significant share of credit extended to improved CRE, and in doing so, forced regional and community banks to change the focus of their CRE lending away from income producing CRE and into construction loans, builder lines of credit, land development loans and raw land loans.
• CMBS 1.0 was characterized by: (1) no future exposure by the loan originator and too many loan originators placed loans with other people's money (Comment: I call this the "merchant lender" mentality – 'if you lend it, someone will buy it'); (2) it did NOT adequately address the current "shut down" scenario (for example, the investment grade investor is given too little "control").
• Some of the lessons learned from CMBS 1.0, and perhaps early characteristics of CMBS 2.0:
  • the B-piece needs to be larger (for meaningful "skin in the game") or even structured out of the deal by having a mezzanine strips in place of a B-piece (the Inland Retail deal is an example of this);
  • the special servicer needs to be independent, or some other mechanism put in place to give the investment grade investor some assurance of impartiality by the special servicer, or the ability to have meaningful input on special servicer decisions;
  • limit the number of investment classes (for example, the DDR, Flagler & Inland Retail issuances in late '09 only have a handful of bond holder classes);
  • single purpose entity (SPE) changes in response to the GGP case; and
  • FINALLY, someone mentioned covered bonds [link to prior posting on covered bonds] – I find it very, very interesting that this comment was quickly brushed aside, as if the covered bond product was irrelevant. (So, if it is irrelevant, then "why" did a former President of the CMSA testify on the Hill in support of the product? Is the CMSA simply focusing on the near term revival of the CMBS market?  What about a long-term fix or better model?)

REAL ESTATE FUNDAMENTALS: "THE FACTS OF LIFE"

If the focus on 2.0 is a bit too out of touch for me, this session just hammered on the current picture of the CRE market:

• unemployment at historical highs (and still rising)
• retail sales still stumbling
• consumer confidence falling
• "asking" commercial rents falling
• commercial leasing activity (absorption) falling
• CRE sales activity: stagnant
• CRE values -43% from the high in 2007
• huge amount of CRE loan maturities over the next three years, with inadequate sources of credit to pay-off those maturities
• huge shortfall in CRE equity (such that it will not fill gap between the credit available and the looming CRE maturities)
• over 75 funds have been formed to buy distressed CRE debt and properties; but little it has been deployed
• very little CRE has been "re-priced" or "re-set" by lenders or servicers foreclosing or disposing of assets
• we're still early in the CRE recover (perhaps only 25% into the process!) (One interesting comment: remember that valuation adjustment occurs early in the CRE recovery process; so we might be 75%-90% into the valuation adjustment process.)
• importantly: no one on the panel, nor else where in the room, foresees an implementation by the Government of an "RTC style" approach (where the Federal government quickly closes large numbers of banks and thrifts, and then quickly sells the loans and assets at steep discounts – resulting in a "harsh pain" but quick re-pricing of CRE
• unlike the late 80s & early 90s: this time there is no new industry (such at technology) to lead the recovery by increasing employment

The audience was very quiet during this session.

BORROWER PANEL: "SURVIVOR"

This panel focused on "how" a borrower could make it through until CRE liquidity returns.

The panel has some advice for borrowers:

• show up with $ if you want to restructure your debt
• if you're in a good city, with good tenants and with DSC (get it?
• Use $ to right-size the loan), then you'll probably survive

It was interesting that while reference was made to splitting up a CMBS loan into an A Note (with good DSC & LTV) and a B Note (representing the "bad" part of the original loan), no one gave any details on the structure (such as the terms of the B Note, the proceeds waterfall between the lender [under the B Note] and the "new" equity [that injected capital needed, in part, to right-size the Note A], the rate of return on the new equity, etc.)

SURVEILLANCE & WORKOUTS: "LET'S MAKE A DEAL'

This panel didn't give any real guidance on terms of workouts, other than to list some basic rules of the game:

Do This:

• be nice
• send all information in; be open and transparent
• sign a pre-negotiations agreement
• keep paying cash flow
• have a reasonable, cogent plan BEFORE you contact the lender or servicer

Do NOT Do This:

• tell lender or servicer that you're "partners"
• tell lender or servicer that you're a good borrower
• "fish" for information or for terms of a plan that will be acceptable
• cry
• hold lender or servicer hostage
• ask for any of the cash flow (nor a cash flow mortgage)
• fly in on a private jet
• offer a bribe
• rob Peter to pay Paul
• launch off on a religious sermon (caveat: "the special servicer knows that it is going to Hell – every day is Hell")
• ask for any return on the new equity infusion made in borrower

It was an interesting day. Much like our experience in Munich – very little clapping at the end of any session (yes, it reminded me a little of the sessions at the EU conference that we attended in October 2008) [link]

In a future posting, I'll cover comments made to us by several elected and appointed Federal officials.

If you have any questions or comments, please post your comment below.